Hard on the heels of President Trump’s complaint in hisState of the Unionaddress about “the injustice of high drug prices,” a new report says that total spending on medicines rose last year by only 1.5%.

Concerns about drug costs have been common among policy makers and within the media in recent years. But the truth about drug costs – and health-care costs in general – is often obscured by rhetoric.

﻿Here are some key facts:

TheTrend Report for 2017issued on Feb. 6 by Express Scripts, the nation’s largest pharmaceutical benefit manager (PBM), finds that for commercial clients per-person spending rose only 1.5%, the smallest increase since the company started measuring in 1993. (Maybe the President should take some credit.)

These new statistics from Express Scripts confirm earlier evidence fromPrime Therapeutics, another large PBM, which found that total spending in the first half of 2017 rose by only 0.8% over the same period the previous year. Prime also found that the price of the most commonly used drugs actually declined.

Thebest datafor 2016 indicate an increase of 1.3% in total spending for prescription drugs – by far the smallest rise in any health-care category.

Prescription drugsrepresent only one-tenthof total health-care costs – a proportion that has remained constant for 15 years. Add in spending on specialized drugs administered in hospitals and doctors’ offices, the share of costs is still only about one-eighth.

Some new medicines, such as cancer treatments, can cost hundreds of thousands of dollars per year. But the enormous value to the patient and to society of such drugs, which each, on average, costbillions of dollarsto develop, is rarely in dispute. Paying for these medicines is reason we have health insurance.

Drug Spending in 2017

The report from Express Scripts is a blockbuster. It shows that unit costs (that is, the cost of the average prescription, or what can be roughly called “price”) rose just 0.7% while utilization (how many prescriptions are issued per health-insurance subscriber) rose 0.8%. Unit costs rose considerably less than the Consumer Price Index, which, according to preliminary figures, was up 2.1% in 2017. In 2016, according to Express Scripts, unit costs rose 2.5% and utilization 1.3%.

The data are even more remarkable when you drill down. “Nearly half of our commercial plans saw their drug spending per beneficiary decrease in 2017,” reports the company. And spending on traditional medicines – that is, the vast majority of commonly used generics and branded drugs – actually declined by 4.3%, “due primarily to a 4.9% drop in unit costs.”

Meanwhile, spending on specialty drugs rose 11.3%, “the lowest increase we’ve seen,” according to Express Scripts. (The increase in 2016 was 13.3%.) The 2017 spending was driven, not by unit costs (which rose just 3.2%) but by increased utilization (8.1%) – a healthy development because it means that these advanced and effective drugs are getting to more Americans, mitigating the virulence of diseases and preventing long hospital stays and early death. (We will have more on the report in our next issue.)

The new Express Scripts numbers dovetail nicely with figures from Prime Therapeutics that we noted inIssue No. 22. Prime found that, for the first half of 2017, overall spending on drugs (both by Prime and its clients) for the firm’s commercial business rose 0.8%, and, again, the driving force was not increased prices but more use of medicines.

The data from the two PBMs are powerful, but, unfortunately, a breakdown of prescription-drug and health-care costs for the entire nation in 2017 will have to wait many more months. Still, there is little doubt about the trend.Competition is driving down the costs of traditional medicines and thus offsetting the effect of the costs of miraculous new medicines. As a result, we’re seeing total spending on drugs rising at less than the pace of inflation.

In IssueNo. 24 of this newsletter, we examined a mass of data for 2016 presented in a Dec. 6 Health Affairs article written by statisticians and economists in the Office of the Actuary at the Centers for Medicare and Medicare Services (CMS).

According to the researchers, the increase in spending on prescription drugs in the United States in 2016 was only 1.3% -- by far the smallest rise in any health-care category. The increase for drugs contrasts with a 4.3% rise overall for national health expenditures (that 4.3%, by the way, is the smallest increase since 2013).

The report noted that annual increases in drug spending of 12.4% in 2014 and 8.9% in 2015 were aberrations, caused largely by pent-up demand for new drugs that cure Hepatitis C and by millions of uninsured Americans gaining access to medicines under the Affordable Care Act.

The researchers wrote that the 1.3% increase in 2016 “is more in line with the lower average annual growth during the period 2010-13 of 1.2% -- a rate that was driven by the shift to more consumption of generic drugs.”

HCCI vs. CMS: How to Reconcile?

But nothing is ever simple in the world of health-care costs. On Jan. 23, the Health Care Cost Institute (HCCI) issued its annual Health Care Cost and Utilization Reportfor 2016. That report looked at employer-based commercial health insurance data for Americans under age 65, and the increase in total spending was about the same as the CMS actuaries reported: 4.6%.

But the increase in prescription-drug spending was far different: 5.1% vs. 1.3%.

Why the discrepancy? Axios Vitals, an online news service, reported the high HCCI figure for drug costs; then,the next day, issued a clarification to provide “additional context to add to the institute’s math on price increases – specifically, drug prices…. HCCI tracked the rising list prices for pharmaceuticals but didn't account for widespread rebates. (Insurance programs often don't pay the full list price.)” Thus, wrote Sam Baker in Vitals, it is “worth noting that some of these price increases aren't always as steep in practice as they look on paper.”

To put it simply, the CMS data (like the Prime and Express Scripts data) subtract rebates from the PBMs, mainly to the employers who pay for commercial insurance; the HCCI data do not. (Imagine if you buy a car for $40,000 and the car dealer later sends you $5,000 as a rebate. What is the actual cost of the car? Clearly, it’s $35,000. Statistics that do not account for rebates give a foggy picture of total costs.)

Of course, if you are looking at year-to-year comparisons and rebates proportions stay constant, then there is no effect, but rebates have been rising. Citing QuintilesIMS data, Adam Fein reported in his blogDrug Channelsthat, while total undiscounted drug spending rose a little less than 40% between 2012 and 2016, off-invoice rebates, discounts, and other prices concessions more than doubled. “An excellent study by Berkelely Research Group (BRG)found that pharmaceutical manufacturers received only 62% of the list price of brand-name and generic drugs,” Fein wrote.

Pernicious Effects of Rebates

“Unlike care received at an in-network hospital or physician’s office, negotiated discounts for medicines are not shared with patients with high deductibles or coinsurance,” says the trade group PhRMA, which has been urging health plans to“share the savings”directly with patients rather than sending rebates to employers.

Rebates are not only unfair to consumers; they also foster pernicious incentives. In 2016, before he was nominated as Commissioner of the Food & Drug Administration, Scott Gottliebtold a congressional committee:The problem is that our current system provides incentives for companies to push list prices higher, only to rebate the money later on the back end. Yet the rebates don’t benefit consumers equally, and they don’t necessarily help offset the costs paid by those who need a particular drug. The rebates eventually make their way back to health plans to help offset the collective costs of premiums.

But if a patient needs a particular drug, they will increasingly find that they are paying the full, negotiated price at the pharmacy counter. They never see the real ‘net’ price, after the rebate is applied much later. The rebate is paid to the health plan, not the patient buying the drug.Gottlieb’s proposed solution is to replace after-the-sale givebacks with transparent up-front discounts. He is now in a position to help reform current practice.

Comparing Categories of Health-Care Spending

The Health Affairs article by the CMS researchers pointed out that prescription drugs accounted for 9.9% percent of total national health-care spending in 2016, compared with 9.7% in 2009. (Figure 1 of this Brookings Institution report shows that the 10% level is the same as in 1960.) Drug spending rose at a considerably lower rate than GDP in five of the seven years reported in the article. By contrast, hospital spending increased considerably faster than GDP in five of the seven years and about the same in other two.

Take a look at page 153 of the Health Affairs issue. It shows that in 2016, hospital expenditures were $1,083 billion; professional services cost $881 billion; and prescription drugs, $329 billion. In other words, hospitals account for about one-third of total health costs; doctors and other professionals, one-fourth; drugs, one-tenth.

Over the seven years covered in the report, hospital spending increased by $261 billion; drug spending, by $76 billion.

Meanwhile, the HCCI report shows one reason why hospitals deserve scrutiny. “Surgical admissions,” says the report, “experienced a 16% decline in utilization from 2012 to 2016.” But, at the same time, total surgical spending over the period rose 9%. The average cost of a surgical admission was $41,702.

One reason for this trend may be that more simple surgeries are taking place in out-patient settings, while complicated and expensive surgeries are left for hospitals. Another is labor. A study by the Progressive Policy Institute found that rising labor costs, mainly at hospitals, “accounted for almost $65 billion in added health care costs in 2015, or 47 percent of the total increase in personal health care spending.” Hospital spending is more than triple prescription-drug spending. Where would you focus your attention if you wanted to control health costs in America?

The Value of New Medicines

In clarifying his Jan. 23 report on the HCCI study, Sam Baker of Axios Vitals wrote that some “expensive new drugs are far more effective than existing treatments. Improved products, of any kind, will always cost more.”

This may be the single most overlooked fact about drug costs. Let’s return to the new Hepatitis C drugs. In more than 90% of cases, these drugscure the disease completelyin only a few months. They are far more effective, with fewer side effects, than previous treatments. Yet reports on prices, or unit costs, of Hepatitis C medicines do not take into account the fact that these drugs are qualitatively different than their predecessors.

The acceleration of dramatic new discoveries – especially in the field of oncology drugs – makes this apples-and-oranges distortion even worse than in the past.

When politicians and journalists criticize the cost of individual specialty drugs, the response should be, “Compared to what?” What is the value of a breast-cancer drug that can extend the life of a patient by five years, compared to the previous gold-standard treatment? There are objective and subjective answers to such a question, and those answers – whatever they may be -- are far from zero. Innovation, by its nature, often raises prices because it offers something better.

The Power of Generics and Bio-Similars

But what makes medicines different from, say, surgeries, is that prices decline over time as patents expire, and more competitors appear. Express Scripts reported that 86% of its clients’ prescriptions are being filled with generics. “When patents and exclusivity run out and generics enter the market, how much do they lower drug spending? A lot,” says a report from theHutchins Centerat Brookings. A 2014National Bureau of Economic Research paperby Rena Conti of the University of Chicago and Ernst Berndt of MIT found “substantial price erosion after generic entry” – 38% to 46% for physician-administered drugs and 25% to 26% for oral drugs.

A studyby Henry Grabowski, a Duke economist, and two colleagues, found that the average new drug has market exclusivity for about 13 years; then, in the first year that generic entry is possible, an average of eight competitors enter the marketplace if the drug’s gross sales are $250 million to $1 billion. The market share of the innovator drug drops to an average of just 11%.Policies that increase competition from generics (which now account for about nine out of every ten prescriptions, up from one out of three in 1994) – as well as from biosimilars, which theFDA deems interchangeablewith a sophisticated biologic product – may be the best way to constrain the cost of drugs while encouraging innovation through market forces.

New, miraculous medicines will, however, still be expensive – which is why insurance was invented. Currently, insurance for drugs, in a perverse twist, lets subscribers pay little or nothing for low-cost generic medicines while requiring them to contribute large amounts out of their own pockets for more costly specialty drugs.

Finally, the HCCI report reminds us that, if policy makers want to have an impact on costs, they should turn their attention toward the destructive effects of the rebates of which PBMs seem to be so fond and toward the categories where the money is: hospitals and out-patient care.